German buyout market eyes next growth phase as standards take shape

Firmer rules are likely to fuel the next phase of deal flow in Germany’s pension buyout market, as companies seek legal clarity before engaging in de-risking transactions.

The gradual establishment of market standards on investment strategies, use of assets, treatment of surpluses or overfunding, and robust transaction oversight will mark the next phase of development of the pension buyout market, Florian Burg, managing director, wealth, at Aon Germany, said.

Aon expects clear best practice to emerge, not only around funding levels of a pension corporation (Rentnergesellschaft), but also on governance structures for transferred pension obligations, with more transactions executed over time, he added.

With clearer standards, confidence among corporates, advisers and other stakeholders involved in buyout deals is expected to strengthen.

“Larger, more transformative transactions could follow at a later stage – particularly once the market has built a track record proving that these structures are both legally robust and reputationally acceptable,” Burg said.

Buyout deals through pension corporations remain only partially regulated, governed for example by corporate law but not insurance law.

“So far regulators have not stepped in because there haven’t been any defaults in pensioner companies, but if this happens, the regulator may step in and will try to find a narrower definition of capitalisation, investment strategy and asset allocation,” said Moritz Jonas, specialist for company pension schemes at Schroders.

Standards on funding, actuarial interest rates and pension adjustments of a pension corporation are currently shaped by what stakeholders consider an outdated ruling of the Federal Labour Court from 2008.

The occupational pension association aba has published a paper with recommendations on the architecture of a pension corporation, cashflow projections, pension promises and the assets required to fund liabilities, which sources described as a compromise.

Despite progress such as the aba paper, regulatory uncertainty remains a significant barrier, causing hesitation among companies – especially those with larger pension liabilities – considering a buyout deal, Tilo Kraus, managing director at buyout firm Vedra Pensions, said.

Barriers and drivers

The share of unfunded plans will determine the future growth of the German pension buyout market.

According to Kraus, around 60% of Germany’s roughly €750bn in pension liabilities remain unfunded, making buyouts difficult, if not impossible, in many cases.

DAX companies hold around €302bn in pension liabilities, with funding ratios of 87%, according to WTW. Non-DAX companies have significantly lower funding levels, Kraus noted.

Inflation spikes and corresponding pension adjustments, volatility in long-term cashflow projections, balance-sheet de-risking – particularly in a volatile economic environment – and the need to improve credit ratings are all incentives for companies to offload liabilities, he added.

This year Germany saw a steady flow of transactions involving banks – including UBS, Credit Suisse and Hauck Aufhäuser Lampe – as well as industrial companies, carried out by a small number of buyout firms.

Banks offload liabilities to meet regulatory requirements, while non-financial companies seek to wind down legacy plans, Kraus said.

Aon expects the pension buyout market to continue to grow, with an emphasis on “acquisition-related portfolios and carve-outs” rather than legacy obligations, as companies look for legal clarity and protection against reputational risk, Burg said.

Capitalisation is key

Corporates are exploring buyouts, while insurers largely remain on the sidelines, applying lower discount rates when pricing deals, which makes transactions expensive, Schroders’ Jonas said.

Companies, therefore, carry out comprehensive and in-depth due diligence on buyout firms that take over liabilities via pension corporations.

From Schroders’ perspective, capitalisation of the pension corporation and its investment strategy are key features of any deal, as the corporate sponsor is unlikely to provide additional capital.

“If the capitalisation is not high enough and incentive structures are inadequate, we would not pitch for the mandate,” Jonas said.

However, each successful transaction is expected to build confidence among German corporates, which increasingly value proven track records, he added.